Sentiment Speaks: Will A Surprise News Event Cause Our Market To Crash Next Week?

| About: SPDR Gold (GLD)

Summary

Price action over prior week.

Anecdotal and other sentiment indications.

Price pattern sentiment indications and upcoming expectations.

I want to begin by noting that this now ranks as one of my more favorite articles to write, purely because it addresses one of the most commonly accepted market fallacies and provides real world examples as to why reliance on those fallacies can steer investors astray.

I sincerely hope you share it with those within your investment circles whether you agree or disagree with my presented propositions, as I believe everyone must at least seriously contemplate this issue rather than believe in what they are fed by the talking heads.

Price Action Over Prior Week

Last week, I posted our expectations in my last article:

In the immediate perspective, as long as we remain below Friday's high, I am still expecting a test of the lower levels cited above.

And, as expected, the market headed down towards our lower target for the 5th wave of this correction, and consolidated near the lower end of our target region before a pre-market spike and reversal on a minor Fib support level at 25.17, just underneath the ideal support region cited.

Even before the market struck the bottom on Thursday, I sent out an alert in our Trading Room at Elliottwavetrader.net with a chart looking for the market to rally off the 25.17 region to the 26-26.50 region, and our higher target was struck later that day. However, I continually noted that if the market was going to prove a bottom was in place, that would only be a wave 1 in a larger wave (I), which should be targeting at least the 28.50 region, from which we recently broke down. A move up towards that region would represent a sizeable 5 wave structure off the low, and would provide us with a strong initial confirmation that we are setting up for another major rally phase.

Anecdotal and Other Sentiment Indications

The question presented in the title to this article is an age old one, with many having very strong views on the matter. And, rightfully so. The talking heads are always pointing out how bad news causes the market to drop or good news causes the market to rally. Many of the headlines we all see on a weekly basis are based upon the same premise.

But we don't ever hear them talking about the market moving up on bad news or down on good news. Have you ever seen the headline "The Economic News Was Great Today, Causing A Strong Drop in the Market?" No, you have not. But we do hear all too often that "markets are just not trading on fundamentals right now," (which is one of the most intellectually dishonest statements I have ever heard).

You see, if the market does not move in the direction one would assume based upon the substance of some news event or fundamentals, the talking heads always look for another reason as to why it moved in the opposite direction, and simply ignore the standard "event causality" reasoning.

But then why is it intellectually honest to assume the market moved based upon the substance of any major news event or fundamentals at any time? Just because it supposedly makes sense within a given time frame? So, we should ignore the news when it does not make sense and not believe in event causality when it does not support our premise, and only highlight it when it makes sense or does support our premise? Do you not see the lack of intellectual honesty and lack of logical consistency in this perspective?

If markets are not trading based upon the news or fundamentals some of the time, then it stands to reason that the market is truly not driven by the substance of the news or fundamentals. And when we see them moving in the same direction, then the announcement of the news was simply the catalyst for the timing of the move, but the substance of the news was not the direct cause. And, yes, the news can still be a catalyst, but it does not mean the substance of the news will identify the direction. In fact, we have often seen markets move in the opposite direction one would have assumed based upon the substance of the underlying news. That is what I mean when I say that a news announcement can be a catalyst, but not the proximate cause determining the direction of the movement.

But what about major, dramatic "surprise" news events? Surely, those must certainly be the direct cause of a major market directional move, right?

In August 1998, the Atlanta Journal-Constitution published an article by Tom Walker, who conducted his own study of 42 years' worth of "surprise" news events and the stock market's corresponding reactions. His conclusion, which will be surprising to most, was that it was exceptionally difficult to identify a connection between market trading and dramatic surprise news. Based upon Walker's study and conclusions, even if you had the news beforehand, you would still not be able to determine the direction of the market only based upon such news.

I know many of you have a very hard time accepting this based upon the fallacies and incorrect suppositions you have been taught throughout the years. But, as Ben Franklin said, Geese are but Geese tho' we may think 'em Swans; and Truth will be Truth tho' it sometimes proves mortifying and distasteful.

So, let's look to some modern examples of surprise news events, like the ones studied by Mr. Walker, but which occurred after his study was conducted.

In our times, the most dramatic news event we have faced in the United States is undoubtedly the catastrophic terrorist attack on 9/11 of 2001. Many consider the events of 9/11 as an example where a surprise news event "caused" a stock market meltdown. Most view this major event as also causing worldwide sentiment to turn negative. This is the common perception of all those to whom I speak about the impression they maintain of this event in relation to the stock market. The problem is that this perspective is simply not supported by the facts.

If one were absolutely convinced of the news directing market direction, then it should be no problem to look at a weekly chart of the S&P 500 and pick out the market reaction to the most significant event occurring in the last 50 years. I mean, it should clearly stand out, especially since it was the most dramatic news event since probably World War II, right?

So, let's look at the chart of 2001. Can you pick out the 9/11 market moving event?

Click to enlarge

When simply glancing at the "box," one would almost assume that the peak of 2001 should be the point in time when the events of 9/11 struck, which was then followed by a strong market decline in reaction to such negative news.

Now, let's look at exactly where the events of 9/11 occurred in the chart:

Click to enlarge

I will bet that most of you did not know that the 9/11 event occurred much closer to the lows of 2001 than the highs? In fact, the market was already in an almost two-year decline before the events of 9/11 struck. Moreover, the reaction to 9/11 seems to have "caused" the market to bottom and rally for four months right after the initial reaction.

Now, would you have expected that the most negative event experienced since the 1940s would be represented right near the lows of 2001, and right before a four-week rally? Probably not. (And for those of you that know your market history, the stock market also struck a major bottom towards the start of WWII and began a 70-year rally).

So, does it not make you question whether horrific or negative surprise world events "cause" sentiment to turn negative, as most people believe? Rather, it seems more plausible that the negative sentiment in effect for well over a year (as evidenced by the stock market decline) before this event occurred potentially ignited the negative actions of 9/11.

I want to pose this question a little differently for you to ponder: Does the negative action of a minority of actors cause the mood of all of society to become negative or does the overall negative social mood of society cause the negative actions of individuals within society?

Please read that question again, and while you ponder the answer, allow me to present a more recent example of a major surprise news event and the resulting market reaction.

Back in November of 2015, we witnessed the worst terrorist attack in France we have seen in modern times. I remember that evening well. My heart went out to the innocent victims of the bombings and attacks in France.

Unfortunately, events like this have occurred throughout human history, and, sadly, will likely continue to occur. People engage in horrific acts for reasons they rationalize as appropriate, no matter how misguided their perspective. This is what ultimately drives certain factions, and causes great upheaval in our world throughout time immemorial. But let's not forget that every generation has had to deal with these types of events and ours is not unique in that regard.

Now, many will view this horrific event in Paris as one which clearly must have had a significant impact upon the financial markets. Many will even note that such an event will cause market sentiment to change towards the negative. While this seems "logical" on its face, does history support the reality of this perspective?

Well, if you look at any time frame chart, you will see that this event actually "caused" a bottom to our equity markets, and we experienced a strong 100-point rally off that low. Yes, you heard me right. The market rallied strongly when it opened after the horrific attacks in France, even though many were quite certain the market would crash based upon the events that evening.

Does that make you scratch your head? Well, if you believe that surprise news events have a direct causal impact upon the market based upon the substance of the news, then you should be scratching your head. And, if one truly believes in applying traditional Newtonian principles of event causality to the financial markets, then this market reaction would clearly not make sense and violate those principles.

I can go on and on with more and more examples throughout the last 100 years. But I think you are starting to see my point. The substance of the news is not the true driver of the market. Rather, market sentiment is the true driver, and when one has a good grasp of market sentiment, none of what I just presented in this article would come as a surprise.

In fact, it would make more sense to those that understand market psychology that an extreme negative action would be seen at the culmination of a negative sentiment trend, which then would turn the market in the opposite direction soon thereafter. Another way that people recognize the same phenomena is when they note that news/fundamentals are best at the highs, and worst at the lows.

To drive this point home even further, have you ever considered the true meaning behind Baron Rothschild's saying that "the time to buy is when there's blood in the streets?"

Back as early as the 1940s, Ralph Nelson Elliott clearly recognized this perspective within our financial markets when he wrote:

The causes of these cyclical changes seem clearly to have their origin in the immutable natural law that governs all things, including the various moods of human behavior. Causes, therefore, tend to become relatively unimportant in the long term progress of the cycle. This fundamental law cannot be subverted or set aside by statutes or restrictions. Current news and political developments are of only incidental importance, soon forgotten; their presumed influence on market trends is not as weighty as is commonly believed."

This same perspective of Elliott's allowed him to act against the prevailing market expectations of his time (as WWII was raging around him and not long after the markets were decimated by the Great Depression), and call for the imminent start to a 70-year bull market. Most consider this to be one of the best stock market calls of all time.

So, while the common perception of the effect of various surprise events may persuade most to view the markets from an event causality perspective (i.e. application of traditional Newtonian principles to financial markets), true students of financial markets know that common perceptions of the majority of the market often lead to wrong conclusions, and, ultimately, losses. While many of you are likely steadfast in your beliefs that events affect market sentiment, I am proposing that the exact opposite is true. In fact, the common perception of the causation chain is opposite of what the reality of history seems to prove.

To this end, I have been following the work of Dr. Cari Bourette (MarketMood.net) who has created an algorithm to track market sentiment based upon the news events of our time on different time scales. Rather than assigning importance to the substance of the news itself, Dr. Bourette tracks public sentiment based upon the nature of the news items to which the majority of the public gravitates. She has successfully translated this into highly accurate stock market timing calls. I think she is a visionary and probably on the leading edge of where financial market analysis is heading in the future. And if you follow her closely, you will be amazed by her insights.

After reading about Mr. Walker's 42-year study published in 1998, and seeing how the markets reacted to the 9/11 or French bombing news, it should make you realize that your underlying assumptions of how news, even surprise news, affects a market is likely not in line with the reality of how markets truly move. So, while I know that this is a very different perspective for many of you to consider, I would implore anyone who is interested in improving the results in their investment accounts to develop a working understanding of social mood and overall market sentiment to better navigate through the stormy seas we call the financial markets.

Price Pattern Sentiment Indications and Upcoming Expectations

Rather than bore you with all the detailed wave structure I present to those interested in our Elliott Wave analysis, I will simply say that we have not developed a strong bottoming signal to suggest we are heading to higher highs just yet. But as long as we remain over 26.80 in the GDX, 125.40 in the GLD, and 19.05 in silver in the upcoming week, we can develop that initial 5-wave structure (towards the 28.50 region in the GDX) to suggest much higher highs are to come.

However, should we break those support levels, it opens the door for the market to head to levels lower than seen this past week, and it may not be a direct move. Until a break does occur, we will not be able to discern whether that lower low will be a direct move or if we have to head higher before dropping to those lower lows. But such a break of support increases the probabilities that we will see a lower low relative to the past week's low. And in the event of a direct break down, the next lower levels to target in the GDX would be in the 22-24.35 region.

Lastly, I would like to repeat what I wrote at the beginning of this article:

I sincerely hope you share it with those within your investment circles whether you agree or disagree with my presented propositions, as I believe everyone must at least seriously contemplate this issue rather than believe in what they are fed by the talking heads.

Disclosure: I am/we are long PHYSICAL METALS AND INDIVIDUAL MINING STOCKS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I may hedge my long portfolio over the coming week.